Top Rupee Forecaster Predicts 10% Rally on Inflows: India Credit

By Jeanette Rodrigues -
Jan 8, 2013

India’s rupee will rise at least 10
percent in 2013, its biggest gain in six years, as central bank
interest-rate cuts spur growth in Asia’s third-largest economy,
according to the most-accurate forecaster.

The currency will strengthen to 50 per dollar, according to
Commerzbank AG, which had the closest estimates in the last six
quarters as measured by Bloomberg Rankings. Dollar-based
investors will earn 14.9 percent, including interest income,
from holding rupees this year, based on the median estimate in a
Bloomberg survey and prevailing deposit rates. That would be the
highest in the world and compares with 8.5 percent on Mexico’s
peso and 6.9 percent on China’s yuan.

“With rate cuts you get the inflows into equities and
bonds,” Charlie Lay, Singapore-based foreign-exchange
strategist at Commerzbank, said in a Jan. 4 telephone interview.
“The economy is showing signs of stabilization.”

Global funds have increased holdings of Indian debt by 26
percent since the end of 2011 to a record, while investors
poured almost $25 billion into stocks last year as Prime
Minister Manmohan Singh unveiled measures to improve growth and
public finances. Inflows will rise further as easing inflation
allows the Reserve Bank of India to lower the highest borrowing
costs among major Asian economies, according to Westpac Banking
Corp. and Barclays Plc, the third- and fourth-best forecasters.

Currency Forecasts

Standard Chartered Plc, ranked second, and Westpac predict
the rupee will appreciate to 53 per dollar by the end of this
year, while Barclays forecasts a level of 53.50 toward the end
of 2013. The currency fell 0.1 percent to 55.3050 today. It
declined 3.5 percent in 2012 after a 16 percent plunge in 2011.

“With moderating inflation, there will be scope for the
RBI to cut rates,” said Commerzbank’s Lay, who expects the
central bank to lower its benchmark repurchase rate by 50 basis
points by March. “It has been a challenging time for policy
makers in the past 12 months given stubbornly high inflation
restricted their ability to lower rates.”

Inflation slowed to a 10-month low of 7.24 percent in
November, the latest period for which figures are available, and
will drop to 7 percent by June, according to the median of nine
analysts in a Bloomberg survey. Price gains have remained above
the RBI’s comfort level of 5 percent for the past three years
and are the highest among the world’s largest emerging markets.
Industrial output unexpectedly rose 8.2 percent in October after
contracting 0.7 percent the previous month, government data
show.

Borrowing Costs

The RBI, which last reduced its benchmark rate in April,
will lower it by 25 basis points to 7.75 percent at its Jan. 29
review, according to eight of 10 analysts in a Bloomberg News
survey. Two predict a 50 point cut.

The yield on the benchmark 10-year bond was little changed
at 7.90 percent today, the lowest level since Dec. 28, 2010,
according to data compiled by Bloomberg.

The rate will drop around 70 basis points over six months,
according to Barclays Plc, which recommends investors buy the
notes. The BSE India Sensitive Index (SENSEX) of shares has climbed 27
percent since the end of 2011 and is 7 percent off its record
close of 21,004.96 reached in November 2010.

Rupee-denominated debt returned 11.3 percent in the past
year, the second-best performance in Asia after Indonesia’s 13.4
percent, according to indexes monitored by HSBC Holdings Plc.

Capital Inflows

Foreign funds have raised investments in rupee-denominated
debt by $7.1 billion since the end of 2011, latest regulator
data show. The holdings touched a record $33.3 billion on Jan.
3. Overseas purchases of the nation’s stocks last year were the
most among 10 developing-Asian markets tracked by Bloomberg,
excluding China. Indian equities saw a withdrawal of $512
million in 2011.

The cost of insuring using five-year credit-default swaps
the debt of government-controlled State Bank of India (SBIN),
considered a proxy for the sovereign by some investors, slid 200
basis points to 195 since the end of 2011, according to data
provider CMA, which is owned by McGraw-Hill Cos. and compiles
prices quoted by dealers in privately negotiated markets. The
contracts pay the buyer face value in exchange for the
underlying securities or the cash equivalent should a borrower
fail to adhere to its debt agreements.

Policy Push

Interest-rate reductions will follow Prime Minister Singh’s
most-aggressive push in a decade to spur investment and curb the
budget deficit. Since mid-September, he has reduced taxes on
companies’ overseas debt, cut energy subsidies and allowed more
foreign holdings in local-currency bonds and in industries
including retailing.

India, the world’s largest bullion buyer, may now raise
taxes on gold imports to help tackle a record current-account
deficit, Finance Minister Palaniappan Chidambaram said Jan. 2.

“The government seems to be exploring every available
option to improve sentiment and further its reform agenda,”
Jonathan Cavenagh, a strategist at Westpac in Singapore, said in
a Jan. 3 telephone interview. “While the taxes on gold won’t be
a dramatic swing factor, India will see inflows and the rupee
will be quite a strong performer for 2013.”

A slump in exports amid a faltering global economy will
stem the rupee’s appreciation this year, with the currency
weakening to 55 per dollar by the end of June before rising in
the second half, Standard Chartered predicts. The British bank
is “neutral” on the currency.

‘Cannot Ignore’

The shortfall in India’s current account, the broadest
measure of trade, widened to $22.3 billion in the three months
through Sept. 30, government data showed Dec. 31. Indian exports
fell for the seventh straight month in November, the longest
stretch of declines since the 2009 global recession, as Europe’s
debt crisis curbs overseas sales.

“What one cannot ignore is the current-account deficit,”
Priyanka Kishore, currency strategist at Standard Chartered in
Mumbai, said in a Jan. 4 interview. “Unless some steps are
taken to narrow this, it does seem that it would be difficult
for the rupee to go into a sustained sharp rally.”

Still, Indian bonds and equities could see “significant”
inflows this year, she said.

The current-account deficit will be funded by capital
inflows, according to Barclays, which expects purchases of
Indian assets to increase after U.S. lawmakers averted more than
$600 billion of tax increases and spending cuts that were to
take effect this year. One-year implied volatility, a gauge of
expected moves in exchange rates used to price options, fell to
15 basis points to 9.55 percent today.

“Over the next month or so, volatility can fall because
some of the global tail risks that markets were facing are
receding, but at the same time the global economy is still
relatively soft,” Nick Verdi, Singapore-based currency
strategist at Barclays, said in a Jan. 4 telephone interview.
“That means that currency markets will be reacting largely on
the back of liquidity, which will remain very flush.”